Palo Alto Networks, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended July 31, 2017. The filing also reports the quarter ended July 31, 2017 (FY2017 Q4). Amounts are in U.S. dollars.
Business context
Palo Alto Networks sells cybersecurity products and services, including next-generation firewalls, endpoint protection, threat-intelligence subscriptions, and support. Sales are primarily through distributors and resellers. The company reported more than 42,500 end-customers across over 150 countries and operates as one reportable segment.
Key financial metrics
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $1,761.6 million | $1,378.5 million |
| Gross profit / gross margin | $1,285.0 million / 72.9% | $1,008.5 million / 73.2% |
| Operating loss / margin | $(179.8) million / (10.2)% | $(157.3) million / (11.4)% |
| Net loss | $(216.6) million | $(192.7) million |
| Cash from operating activities | $868.5 million | $658.6 million |
| Free cash flow (non-GAAP) | $705.1 million | $586.1 million |
| Billings | $2,293.4 million | $1,905.6 million |
| Cash, cash equivalents and investments | $2,164.3 million | $1,938.4 million |
| Total deferred revenue | $1,773.5 million | $1,240.8 million |
| Working capital | $775.0 million | $927.2 million |
FY2017 product revenue was $709.1 million, up 5.7%; subscription and support revenue was $1,052.5 million, up 48.7%, and represented 59.7% of total revenue. Revenue grew 27.8%, compared with 48.5% growth in FY2016. The company attributed operating cash generation largely to business growth, higher billings, and collections.
At July 31, 2017, the company had $575.0 million principal amount of 0.0% convertible senior notes due July 2019, carried at $524.7 million net. The filing states all notes remained outstanding. Contractual obligations included $517.5 million of operating lease commitments and $104.1 million of purchase commitments.
FY2017 Q4: Revenue was $509.1 million, compared with $400.8 million in FY2016 Q4. Gross profit was $370.6 million; operating loss was $27.3 million; net loss was $38.2 million, or $0.42 per share.
Material changes versus prior period
- Annual revenue growth slowed to 27.8% from 48.5%, though subscription and support continued to grow rapidly and increased as a share of revenue.
- Product gross margin declined to 71.6% from 73.9%, primarily due to higher costs on newly introduced appliances. Subscription and support gross margin increased to 73.9% from 72.5%.
- Operating loss increased in dollars, while operating margin improved to (10.2)% from (11.4)%. Net loss widened to $216.6 million from $192.7 million.
- Operating cash flow rose to $868.5 million from $658.6 million. Investing cash outflow increased, including $90.7 million net cash paid for the LightCyber acquisition and higher facilities investment.
- Financing cash outflow was $386.0 million, including $411.0 million of share repurchases. The company repurchased and retired 3.3 million shares for $420.1 million including transaction costs; $580.0 million remained authorized.
Outlook, commentary, risks and unusual items
- Management expected operating expenses to increase in absolute dollars, including continued investment in research and development, sales and marketing, customer support, and international expansion. The filing provides no specific FY2018 revenue or earnings guidance.
- Planned offerings included GlobalProtect Cloud Service and Logging Service, expected in September 2017, and the Application Framework, expected to become generally available in early calendar 2018. These are forward-looking expectations, not reported results.
- Management said cash flow from operations, together with existing cash and cash equivalents, was expected to meet anticipated cash needs for the foreseeable future. The company also anticipated continued operating losses and noted its accumulated deficit was $836.7 million.
- In February 2017, the company acquired LightCyber for $103.1 million in cash, adding behavioral analytics technology.
- The headquarters relocation resulted in a $20.9 million property and equipment impairment in FY2017. Following the August 2017 move, the company expected an additional cease-use loss of approximately $15.4 million in FY2018 Q1.
- The company voluntarily changed its sales-commission accounting, retrospectively deferring and amortizing qualifying commissions over contract terms. This change reduced the reported FY2017 net loss by $39.7 million versus the prior method; cash flows were not changed by this policy change. FY2017 and comparative results also reflect adoption of updated share-based payment accounting guidance.
- Key risks include intense competition, dependence on channel partners and a small number of distributors, cybersecurity incidents or product defects, execution of sales strategy, supply-chain reliance, and customer renewal and subscription demand. Three distributors accounted for 65.7% of FY2017 revenue, and four accounted for 75.9% of gross receivables at year-end.
- The CFO had advised of his intent to retire. The filing also highlights uncertainty around tax positions, including $301.3 million of unrecognized tax benefits, and the potential effects of the new revenue-recognition standard, which the company planned to adopt in FY2019.
Important facts for investors to verify
- Track subscription and support growth, renewal performance, deferred revenue and billings against recognized revenue.
- Assess whether the company can improve GAAP profitability as expenses and share-based compensation remain substantial; FY2017 share-based compensation was $475.7 million.
- Review distributor concentration, receivable exposure, and the company’s capacity to maintain supply and customer support.
- Monitor the 2019 convertible notes, share repurchases, substantial lease commitments, and the impact of the headquarters relocation.
- Confirm delivery and commercial adoption of planned cloud offerings and the Application Framework; the filing does not establish that these launches or expected benefits were achieved.
- Consider the effects of the commission accounting change and other accounting adoptions when comparing reported periods.